Another mortgage crisis might be just around the corner

Donald
Duck peaks around the corner at the start of a Hollywood Walk of
Fame ceremony, in Los Angeles, California.Reuters/Reuters
Photographer

The U.S. could be headed for a new mortgage crisis by this
summer, believes one analyst. Richard X. Bove, Vice President of
Equity Research at Rafferty Capital Markets, said in a report
dated March 1 that it’s looking increasingly likely that we will
see one. He highlighted how much control the government now has
over the nation’s mortgage markets and explained how this could
be a recipe for disaster.

U.S. government controls the mortgage markets

Bove pointed out that the U.S. government now insures one-fourth
of all new residential mortgage loans and purchases one-sixth of
all residential mortgage loans issued. Further,
government-sponsored enterprises Fannie May, Freddie Mac and
Ginnie Mae own or ensure three-fifths of all current outstanding
mortgages in the country, and the problem is getting worse and
worse every quarter, he said.

He added that the government continues to increase its direct
ownership of the mortgages as well, suggesting that we could see
a whole new mortgage crisis characterized by the government
getting too deeply entrenched in it.

Fannie Mae, Freddie Mac rule the roost

Bove notes that Fannie Mae and Freddie Mac together either own or
insure 45.9% of the mortgage market right now, amounting to $4.6
trillion in total. In 2009, the two government-sponsored enterprises owned or
insured 41.9% of the market. Following Fannie and Freddie is the
private sector in terms of size, as he said it controls 38.8% of
outstanding mortgages, amounting to $3.9 trillion.

Ginnie Mae is wholly owned by the government, and although it
currently sits at the bottom of the mortgage market in terms of
size, he said it’s the fastest growing. Currently it holds 15.2%
of the market at $1.5 trillion worth of mortgages. In 2009, its
share was only 5.7%. In fact, Bove said Ginnie is growing so
rapidly that it’s stealing market share not only from the private
sector but also from Freddie and Fannie as well.

U.S. government keeps intervening

Further, he said the government keeps intervening in the mortgage
payment insurance industry through three main agencies: the
Federal Housing Administration, the Department of Veterans
Affairs and the Department of Agriculture. The FHA’s share of the
market nearly doubled from 2004 to 2015 from 23.6% to 40.6%, and
the agency has made sure to keep its iron grip on the market.
Bove said that in 2014, its market share started to decline, and
then in January 2015, the agency slashed its rates by 50 basis
points to gain back the share it lost.

The Department of Veterans Affairs has seen its market share slip
slightly over the last 11 years from 23.7% in 2004 to 22.8% last
year. Mortgage insurers in the private sector are the ones giving
up market share, he added. In 2004, they held a 66.6% share, but
by 2015, private insurers’ share of the market had been sliced
just about in half to 33.8%. One bright area Bove noted though is
that they are beginning to come back after bottoming out at a
14.9% share in 2009.

A row of homes in Kansas City.Wikimedia Commons

Insured mortgage payments reach a 100-year high

So exactly how did the government gain such a dominant position
in the mortgage industry? For one thing, he noted that in the
last mortgage crisis, officials established some programs to help
homeowners who were about to default on their loans. Second, he
said the government changed the banking rules, causing banks to
pull away from mortgage origination.

Third, he said the government pushed mortgages from Freddie and
Fannie back to the banks and then started reneging on the
guarantees set through the FHA. And fourth, he said it allowed
brokers and bankers to steal share from banks in mortgage
origination. This last one is a big problem because brokers
quickly discovered that the fastest way to get mortgages approved
was through the FHA, and then to get it off their balance sheets
quickly, they sold them to Ginnie.

A new mortgage crisis sparked by the government’s involvement?

Bove suggests that the current setup with the government
dominating the mortgage industry isn’t sustainable. For one
thing, it has ruled that Fannie and Freddie must not have any
capital by the end of 2017 by taking all of their earnings, plus
more, each quarter. This sparked a feud between Fannie and
Freddie shareholders and the government as they fought back in an
attempt to protect their investments. However, they have been
unsuccessful and as a result, both GSEs have essentially become
insolvent, said Bove, which contributes to his view that a
mortgage crisis could be imminent.

Fannie
MaeMark Wilson/Getty
Images

Why does all this point to a possible mortgage crisis in just a
few months?

The Rafferty analyst believes the mortgage market is too
comfortable with the government’s controldespite Fannie’s and
Freddie’s insolvency. He said lenders assume that both GSEs’ debt
is guaranteed by the government’s credit, but it’s unclear that
this is actually true. He added that it’s unclear that the
government would even honor the debt if a crisis occurs.

True, the GSEs can draw down money from the U.S. Treasury after
their equity runs out, and their respective managements insist
that this will protect all that debt. Bove questions whether they
will actually be able to borrow from the Treasury, however, even
though they have the right to do so, and a mortgage crisis could
result.

“What would happen if the politicians heard that the Treasury had
bankrupted Fannie Mae and Freddie Mac?” he queried.

He believes that if either of them sought money from the
government during election season, it would turn into an
“explosive issue.”

“I do not believe that the current Administration could defend
its actions in bankrupting both companies or in driving them
into insolvency,” he concluded. “The whole government approach
to financial stabilization, which is now not trusted because
bank stocks are plunging, would be called into question. Time
is ticking on the GSE issue because they are totally incapable
of meeting their obligations if the country slips into
recession – and Mel Watt, the GSE regulator knows it.

“If Fannie and Freddie seek more money from the government, the
lynch pin will have been pulled on the government owned
mortgage markets. The little boy will have pulled his finger
out of the dyke and housing will be inundated.”